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Can Boohoo.com justify a higher share price?

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After touching a two-year low of 140p in April, shares in online fashion retailer Boohoo.com (LSE: BOO) have since rebounded strongly, gaining 43% in under three months to 201p. But despite the impressive run, Boohoo still trades well below last year’s record high of 273p.

Rapid growth

Boohoo’s recent growth history is extraordinary. In the five years to 2018, revenues have increased nearly eight-folds to £580m, while pre-tax profits have soared nearly 14 times to £43.3m last year. Over that time, the ultrafast-fashion retailer has made new in-roads into the US and other international markets, and acquired labels PrettyLittleThing and Nasty Gal.

Highly-prized growth stocks invariably have an impressive story that helps justify the case. For Boohoo, it’s by making fast fashion even faster. Known as “test and repeat”, Boohoo’s strategy relies on ordering small quantities of a wide range of designs and products before reordering those that prove popular for bigger production runs.

This all-action business model enables Boohoo to bring new styles to market in as little as two weeks, allowing it to respond much more quickly to changing fashion tastes than its rivals. Even fast fashion retail giants such as Zara and Uniqlo cannot match their speed to market, giving firms such as Boohoo a big competitive edge when it comes to innovation.

Pricey valuation

It’s easy to see why so many investors admire Boohoo — it’s certainly well-managed, and robust growth looks assured for at least a few more years to come. By contrast, however, value investors may find it difficult to justify such a pricey multiple for the stock.

With operating margins of just 8.7%, it’s not as profitable as many would expect. Margins have also declined sharply in recent years as the company sacrificed profits for future growth. Its growth spurt has come at the cost of huge investments both in prices and infrastructure. But it’s not yet clear whether it will eventually be able to raise prices without losing sales.

Shares in Boohoo trade at 52 times its forecast earnings this year, on projected bottom line growth of 16%. That sort of high multiple on earnings is hard to find elsewhere, although so is its forecast growth.

A better buy?

Instead, Primark-owner Associated British Foods (LSE: ABF) may be a cheaper play in the fashion retail scene.

At first glance, the company doesn’t necessarily scream value, with shares in the conglomerate trading 21 times its expected earnings this year. But when we take into account its future growth prospects and recent weakness at its sugar business, I reckon there’s a strong case for further gains in its share price.

Unlike most high street fashion retailers, Primark is still generating healthy revenue growth, and contributing to an ever greater share of the group’s profits. Although growth has recently slowed amid weak consumer confidence in the UK, there’s growing optimism that the retailer’s like-for-like sales growth could soon be at an inflection point.

There are a number of bullish catalysts for Primark in the near-term, which include a possible rollout of more stores in the US, the closure of dozens of New Look and House of Fraser stores and other new store openings. And then for ABF as a whole, there’s the possible recovery in sugar business and the impact of operational improvements to the rest of the agri-foods business.

Buy-And-Hold Investing

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Jack Tang has no position in any of the shares mentioned. The Motley Fool UK has recommended Associated British Foods and boohoo.com. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.